Gold -- a victim of its own success

Expanded investment horizon for the metal may shift traders' view

SAN FRANCISCO (MarketWatch) - Gold may just be a victim of its own success.

Traditionally, the precious metal has been seen as a way to hedge against losses in times of financial crisis and economic or political uncertainty -- and there's certainly been a great deal of that in the global markets recently.

'Gold has moved from being a beneficiary of a stock market sell-off -- to a victim.'
Kevin Kerr, Global Resources Trader

But "the gold market has thus far been frustratingly unable to summon its historical safe-haven attributes," said Jon Nadler, an analyst at Kitco Bullion Dealers.

"When you have bullion moving in tandem with equities, you have to scratch your head," he said. And "the last thing the traditional buyers want from gold is for it not to perform when the going gets tough in paper assets."

The various means by which gold is acquired and sold has expanded -- and that diversity has been both a friend and enemy, feeding a very volatile trading environment.

Gold has "evolved so much that now investors are faced with numerous choices on how to own the precious metal," said Kevin Kerr, editor of Global Resources Trader, a newsletter of MarketWatch, the publisher of this report.

"Gone are the days of merely futures and bullion. Today, investors have a wide variety of exchange-traded funds, hedge funds, mining shares and a myriad of futures and options contracts all over the globe," he said.

At the same time, "what's happened is that gold has moved from being a beneficiary of a stock market sell-off -- to a victim," he said.

Subject of success

So you might say gold's a victim of its own success.

"The apparent quest for liquidity among global investors has made gold a victim to its own recent success," Nadler said. "A preference for cash is evidently excluding the ultimate form of cash that gold is normally thought to be." See an interview with Nadler.

Still, Amaury Conti, an equity trader at San Antonio, Texas-based Austin, Calvert & Flavin Inc., doesn't believe the view of gold has really changed. It's the way to trade it that's different.

"Gold will go up in uncertain times as it usually does, but now the ability for a trader to sell the ETF and go short has changed the liquidity and risk dynamics of the asset," he said. The first U.S. gold ETF, the StreetTracks Gold Trust ETF
GLD, -0.23%
was launched in late 2004.

And "any source of ready cash -- even crisis-hedge investments like gold -- will be liquidated to meet trading liabilities," said Brien Lundin, editor of the Gold Newsletter.

That's what happened in the wake of Feb. 27, when U.S. stocks saw their biggest one-day drop in more than 5 years. That day, gold prices fell -- and kept falling for a total of five sessions.

All told, as of Thursday, they've fallen in nine out 13 trading sessions.

Gold futures still trade above the $638 level they finished at last year, but they're well below the more than $690 price they saw in late February.

"Stock markets across the world suddenly plunged ... It is probable that the value of some portfolios sharply decreased within a few days," said Frederic Panizzutti, senior vice president at MKS Financial in Geneva.

"One had certainly expected gold to rally further in that situation ... as the need for a safe haven should have increased," he said. "Gold collapsed rapidly instead."

Panizzutti attributed the price fall to "profit taking," as opposed to any change of view, direction or trend in gold.

"Gold acted rather as insurance than a safe haven," he said.

The bottom line: "the reasons to own gold for diversification and protection continue to dominate, but an investor has to deal with some added volatility and be patient," said Conti.

Expanding horizons

The emergence of gold ETFs has allowed investors of "all stripes to ostensibly buy physical gold with the same ease with which they'd buy a mutual fund," said Lundin.

"In some ways, one could say that with these new investment methods, gold has indeed become more attractive as money, once again elevating its profile," said Peter Spina, a chief investment strategist at GoldSeek.com.

He pointed out that online services such as GoldMoney.com offer traders easy access to the physical metal without the worry of holding or storing it. And "new innovations such as digital currency backed by gold could be an emerging demand factor not closely followed," he said.

Indeed, a question that needed to be answered is "how 'sticky'" are ETF investments, said Lundin. "Are those who buy the ETFs primarily traders who move in and out with regularity, or buy-and-hold investors who purchase gold for its traditional safe-have role?"

The issue was put to the test during the recent breakdown in global markets, Lundin said. ETF trading was volatile, but there was no wholesale sell-off of gold holdings in the ETFs.

So it appears that "a very large percentage of investors use these vehicles as part of a buy-and-hold strategy, and seem unlikely to sell in any large-scale, hair-trigger fashion," he said.

Given that, Lundin said gold ETFs should continue to attract a growing community of investors to gold and to drain supply from the world market.

Prognosis

The "price action in precious metals when all other global markets seemed to be melting down should not be looked at as anything other than a short-term occurrence," said Neal Ryan, director of economic research at Blanchard.

"Precious metals became the easy liquidation target to raise capital for those fund investors and institutions because they were sitting on a 12% increase year to date," he said.

"Short term, it caused a bit of heartburn, but medium to long term, the pandemonium caused by liquidity concerns and the unwinding of the yen-carry trade highlight the trouble of focused positions," he said. Carry trades refer to the practice of investors borrowing or selling low-yielding currencies and reinvesting in higher-return currencies and assets.

"Investors keep relearning the same messages," said Ryan. "A diversified asset base is key to long-term growth -- that includes precious metals."

Despite the more upbeat, longer-term expectations for gold, traders admit "there is no doubt that gold failed in some regards recently and that owners are a bit apprehensive," said Kitco's Nadler.

This stage "shall pass, but for the moment the $1,000 pundits have some very visible egg on their faces," he said. And now, "gold must prove its age-old attributes and not only find a footing, but be aggressively sought out by investors."

So in the end, gold will eventually end up doing what it's historically been known to do -- gain in value.

"The long-term prognosis remains bright," said Julian Phillips, an analyst at GoldForecaster.com. It has actually "moved into a position so as to be ready to move much higher once this consolidation is over."

"The next major upside objectives remain $730, then $850 followed by $1,000," he said.

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